3/10/2009 @ 11:30AM

Beijing: One Month Of Falling Prices Is Not Deflation

Notwithstanding Beijings denials, the latest Consumer Price Index figure showed that China has entered the realm of deflation for the first time in more than six years.

The National Bureau of Statistics released data on Tuesday indicating that China’s Consumer Price Index in February fell to minus 1.6% from a year earlier. That was the first negative reading since December 2002. The CPI in the first two months of the year dropped by 0.3% from the same period last year, the agency said.

Food prices dropped across the board in February relative to last year, with meat falling by 8.8% and edible oils tumbling by 17.2%. Nonfood prices are also down, by 1.2%, year on year, and prices for services declined by 1.8% from a year ago.

China also published its Producer Price Index, which dived by 4.5% in February, compared with a 3.3% drop in January.

Deflation is caused by either a reduction in the supply of money and credit, or by a decrease in government, personal and investment spending. However, China claimed that the February figure did not represent a deflation problem.

“The fall of the CPI and PPI in February was mainly due to significant declines in the prices of international primary products and some special factors. We can’t jump to the conclusion that there is deflation, the National Bureau of Statistics wrote in a statement, adding that liquidity supply is sufficient, bank loans are growing rapidly and there is no problem of a shortage of currency in circulation.”

According to initial statistics, aggregate new loans in February were still above 1 trillion yuan ($146.1 billion), the bureau said.

Beijing expects an inflation rate of just below 4% for the entire 2009, but many economists forecast deflationary pressures instead.

Eric Fishwick, head of economic research at CLSA, said, As elsewhere deflation in China is becoming increasingly pervasive. For manufacturers falling selling prices are a profits headwind on top of declines in shipment volumes. For all deflation makes for a difficult environment for monetary policy to gain traction.

China however is at the front of the move to deflation because its import prices have remained stable due to its currency remaining static vs. the U.S. dollar, Fishwick continued in his note to clients.

Jing Ulrich, chairman of China equities at JPMorgan Hong Kong, said the deflation problem in China will just be a temporary phenomenon. That being said, we believe that the government may take additional steps to avoid an extended period of deflation. Further interest rate cuts and RRR [required reserve ratio] adjustments may be made, and additional measures to stimulate consumption could be introduced.

She went on to observe, Producer price growth is likely to remain in negative territory during the first half of the year, but the 4 trillion yuan stimulus package and ample liquidity may cause inflation to regain momentum if the economy starts to recover. In this sense, near-term deflationary pressure could give way to inflationary risks in the long run.